Miscellaneous

Section J-2Contingencies

Introduction

A well planned construction project will typically lead to a better project outcome.

This Best Practice paper will endeavor to give you some ideas how the proper use and application of contingencies can help make a better overall result for your project. At the onset of the project, the entire construction team would like to know how much the project will cost to complete. The known facts of a project can lead the team to an estimate, but the unknowns still need to be accounted for – that is to say that even the most experienced Architects, Constructors and specialized consultants working on a project cannot precisely predict the exact cost of a project due to the unforeseen circumstances that occur on construction projects.

A common way to help budget for inexact cost and unforeseen conditions is to establish an amount of money as part of the project budget to cover these unknowns. One of the challenges is identifying the risks of the project and properly providing for those risks in the budget. The money allocated to cover these risks is referred to as the contingency.

The Joint Committee recommends that every construction project budget contains and funds a contingency.

Types of Contingencies

There are many types of contingencies that may be applied to a project budget. The following are examples of the most commonly used contingencies:

Design/Estimating Contingency – This type of contingency can be used to account for the cost of work still required by the progression of the project design. It can be also be used to account for potential inaccuracies in the budget estimate. It is typically appropriate to have a larger design contingency at the early stages of design. It can be reduced as detail is added to the project design. The cost of the contingency can be better defined as the design detail of the project progresses.

Construction Contingency – This type of contingency can be used to account for general unknown conditions that may affect the execution of the construction work. This amount is for the exclusive use of the Constructor to cover risks such as scope gap, unforeseen trade coordination, premium time, and other undefined risks.

Owner (Project) Contingency – This is a generic term for a contingency the Owner may carry in conjunction with, or in lieu of, other more specific contingencies and is typically outside the project scope. It can be used to cover scope changes or unknown costs in design, construction and/or soft costs such as fee.

While this recommendation only highlights the few, more commonly used contingency types, a construction project allows the opportunity to create other types of contingencies. As other types are encountered and an explanation is needed, readers should contact the AIA-MBA Joint Committee.

Use & Management of Contingencies

Using a contingency provides the ability to proceed with a project budget in spite of the risks inherent in any project. Contingencies should be presented as simply as possible. Using contingency during the course of the project should be done with careful discipline and communication. The project team should establish a clear understanding of who has what authority to assign contingency funds to cover actual project costs. The team should also agree on the timing for the assignment of contingency money. Formal assignment of contingency funds may, for example, be limited only to regularly planned meeting or reporting times that allow for discussion by the principal parties of the project team. Similarly, the Constructor’s project manager might be authorized to use particular parts of the contingency, or may be given a dollar limit, requiring agreement by other team members for other amounts.

Just as the development of a project’s contingencies has many facets, so does the use and management of the contingency funds. Over the life of the project, contingencies are reallocated to previously unknown or underestimated items of work. This reallocation should be as overt as possible. All of the parties involved in a project must understand how, when, and for what purpose the contingency funds are applied and consumed.

Terms should be established in the agreement for unused contingencies, including shared savings clauses for the construction team. The parameters of the project and how the final construction contract value was established will affect options for any shared savings clause.

The Structure of Contingencies:

The Joint Committee recommends that project Owners contact a proven industry professional early in the planning of a project to assist them to identify needs for contingency. A knowledgeable professional can help create and fund contingencies at an appropriate level. New estimates may be created at various steps in the process, leading to the creation of new contingency funds, without any clear allocation of the previous contingency. This can be a successful approach, provided the new contingency has a sound basis. Simply reducing the contingency because more detail has been developed is a dangerous simplification. The new contingency should be developed with the same methodical care as its predecessor.

Once a baseline estimate is established any change in the contingency should be clearly allocated and communicated. It is natural for the size of a contingency to be reduced as more estimating detail is known or more progress is made in the work. However, it is imperative that any change in contingency be clearly communicated. It is easy to understand that if new information indicates that there is an increase in the cost of part of the work, then dollars should be subtracted from the contingency and added to the particular work item. In this case, the total projected cost of the project does not change. The opposite case is often overlooked. If a part of the project proves less expensive than predicted, that savings should be added to the contingency fund. The overall cost projection, again, does not change, unless the team has agreed to a change in the project estimate.

If the overall expected cost of the work is less, or new information justifies a reduction in contingency, then the appropriate reduction in the estimated cost of completion should be agreed to by the project team and a formal change issued. This formal change in the expected cost of the project may, or may not, include a change in contingency. For example, if a contingency was developed to address uncertainty in the cost of certain materials or unknown structural conditions in an existing building, but it was less expensive, than the expected savings could have no bearing on the contingency.

In the same manner, if the overall expected cost of the work increases, or new information justifies an increase in contingency, then the appropriate change in the estimated cost of completion should be agreed to by the project team and a formal change issued. If the new information is related to the basis of the contingency, then a change in contingency is appropriate.

NOTE: Special attention should be paid to renovation projects in establishing the contingency value and for what uses it can be expended. Actual conditions can vary from the drawn conditions will require clarity from which contingency the differing condition should be paid. The agreement should address such potential conditions to support the contingency values established.

The Responsibility for Contingencies:

Whether funds are reallocated between work items and contingency, resulting in no change to the project budget or the overall budget is adjusted (with or without a change in contingency), the rationale and the accounting must be justifiable and clearly communicated to all parties to the project. It is strongly recommended that the level of authority be properly assigned in these two cases. For example, the project manager may have the authority to reallocate funds within the budget, but a change to the budget may require approval of the project sponsor and any changes should be communicated.

The assignment, and respect for, appropriate decision making authority is crucial to the use and management of contingencies. The team should clearly define the roles and responsibilities of those with authority to manage the contingency(ies). Assignment, allocation and control of contingencies must be controlled within the context of these authority levels. If a contingency fund is established to address market uncertainties related to material costs, consumption or change of this fund may lie within the authority of the Constructor. Responsibility for contingencies addressing unknown existing conditions may fall within the control of the Owner. Successful use and management of contingencies requires clear understanding and communication of the basis for the contingencies and the authority for their use.

A good first step to start the discussion of contingencies with the construction team can be found in either of the following two industry standard agreements: AIA Document A133-2007 Standard Form of Agreement Between Owner and Construction Manager as Constructoror the ConsensusDOCS 500 Owner/Construction Manager & General Conditions (At-Risk).